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Tuesday, October 15, 2013

Bubble bubble, toil and trouble

Apologies for
distorting Shakespeare’s Macbeth, but
recent talk of a housing ‘bubble’ in Australia is increasingly reminiscent of Soothsayers
with bubbling cauldrons of economic brew.While dire warnings of
impending doom are taking things too far, there are good reasons to be
concerned about housing dysfunction in Australia.

The definition of a market bubble is where prices trade at
high volumes and at prices which are detached from intrinsic value. We usually
only spot a bubble after the event – when prices drop sharply. Australia’s
housing markets may be dysfunctional and structurally distorted by taxes and
regulation, but to suggest they are in a ‘bubble’ is a simplistic observation
based mainly on some recent positive movements in the established house markets
of Sydney and Melbourne.

One of my main complaints with many economists and much of
the media is that they treat Australia’s housing market as a single product,
equally subject to the laws of supply and demand. Apart from obvious geographic
differences, there are very large differences between the established housing
markets (trading of second hand homes in established areas) and new housing
development. Few commentators, policy makers or reporters seem to understand
the significant impact on input prices for new housing of things like complex planning
regulations, the long lead times on new supply, the distortions to supply
imposed by urban growth boundaries, the differential tax treatments on new
supply through the GST and the per-dwelling infrastructure levies - none of
which apply to established housing.

This weight of this regulatory and tax burden has largely
been created by various state and local governments from the late 1990s onwards. It’s had a dramatic impact on new housing construction, pushing our rate of
new dwelling supply per thousand of population to a thirty year low. Anyone
looking at this depressing graph would be hard pressed to be talking about a
‘bubble’ in the Australian housing market:

While new taxes and regulation have succeeded in pushing the
new housing market to a 30 year low in terms of new supply, the same can’t be
said for the established housing market which has largely been left untouched
by regulatory or tax creep for decades. It would be political suicide for a
government of any persuasion to tamper with taxes or regulation of existing housing.
(Somehow though, the same political caution hasn’t been felt in terms of new housing).

So the performance of the established housing market has been
in stark contrast to the new housing market. And it is graphs like this which
have ‘bubble’ proponents staring deep into their cauldrons:

The latter shows that established house prices in major
centres have risen dramatically, relative to measures of economic growth and to
average incomes. Does this constitute a bubble?

Certainly, for people on average incomes, entering the
housing market via the established house market, especially in inner city or
mid ring areas where supply of vacant land has been all but exhausted, can now be
prohibitive.Supply is constrained because
established areas are built out. More people wanting to live in these areas
means rising demand relative to supply, and when economic conditions permit (as
they do now) prices rise.

With median house prices (based as they are on the sale of
established houses) hovering around the $500,000 mark in many cities, you would
ideally need a combined household income of $100,000 for this to be anything
like affordable. $150,000 would be better. Having said that, there are enough
families with two incomes bringing in over $100,000 per annum so that
housing at this level is still accessible for some. But if your combined household
income is less than $70,000 per annum, you’d be pretty much locked out of many housing
opportunities in established areas. And there are also plenty of families and
individuals who fit that description today.

So while I don’t see a ‘bubble’ I do see a structural
problem which needs to be addressed. And that problem is that where once
Australian cities offered a ‘pressure valve’ via low cost, entry level housing
on the urban outskirts, the price advantage of this option has now been removed
by public policy changes.

The arrival of Urban Growth Boundaries (UGBs) in the late 1990s
to early 2000s created an immediate shortage of low cost land for new housing. Market
pressure built up within these artificial boundaries and vacant land prices shot
up, while lot sizes fell – a double whammy. The GST - which applies only to new
housing - added 10% to the cost of a new home, and infrastructure levies
compounded the problem, adding in many cases $30,000 to $50,000 per dwelling.
Soon enough, we reached the point where between a third and 40% of the cost of
a new home could be attributed to new policy initiatives delivered via our
planning regulators and Treasuries.

Remember, the actual building cost of detached housing has
remained largely unchanged for decades – at around $1000 to $1200 per square metre.
But the land cost on which that house sits has skyrocketed, as have taxes on
new housing, as has the regulatory compliance cost. So the new house and land
option, which was once a low cost pressure valve accessible to young families
and low to moderate income groups, quickly became just as expensive as
established housing in inner city and middle ring areas. Little wonder the rate
of new supply collapsed so quickly.

Look again at the graph above. The market distortion took
hold in the early 2000s. It doesn’t matter whose graphs or analysis you use, it
was around this time that prices for housing started to move well out of sync
with incomes or measures of economic activity. It was also around this time
that State Governments were busy extolling the virtues of growth boundaries to ‘contain
sprawl’ and plan for ‘sustainable futures.’ It was around this same time that
State and Local Governments latched onto the idea of per lot infrastructure
levies on new housing as a means of raising revenues. It was around this time
that the GST arrived, applying as it did only to new housing. It was a triple
whammy effect that has so distorted housing markets that there are virtually no
low-cost entry-level options left. The pressure continues to build on existing
house prices while the new building market continues to suffer. That pressure
isn’t coming from first home buyers, but from people already in the market:
upgraders and investors. It’s also coming from overseas buyers, and (worryingly)
from geared Self-Managed Super Funds.

Talk of an Australian housing market ‘bubble’ is too
simplistic but appeals to media appetites for ‘boom’ and ‘bust’ scenarios. The
real story behind Australian housing markets is more complex. For those
prepared to invest some time looking into it, the signs of markets distorted by
inequitable regulatory and tax measures are immediately apparent, particularly
as they apply to new supply.